Seniors should go slow in first entering stock fund market

YOUR FUNDS

Shortly thereafter, she was reading a column online which talked about the historical returns of stocks and bonds, and she printed it to show her husband, Don.

Don took the information to heart. Recognizing that a portfolio made up entirely of bonds and bank deposits is not likely to earn as much as a portfolio of stocks over time, he now wants to move all of the couple's liquid assets to stocks.

Having reached her 70s without ever having purchased a stock mutual fund, Anne is skeptical. So she sent me an e-mail - one of her first e-mails ever - wondering how a couple who has never owned mutual funds might get into them without "going overboard, or finding some way to lose everything and have a mutual fund go to zero."

What's unusual about the Palm Beach, Fla., couple is that they have reached their 70s without investing in stocks. But their situation is hardly unique, as investors of all ages have to come to grips with the right way to invest and sleep at night, which involves balancing their risks.

Having waited so long to invest, Anne and Don presumably were trying to keep their money safe (we have to presume it because Anne apparently doesn't check her e-mail very often). By keeping it out of the stock market, they eliminated market risk, which is the chance that stocks decline, cutting into their principal.

By going entirely into Treasury bonds and certificates of deposit, they gave a big sloppy embrace to what most experts call "purchasing-power risk," or the risk that their buying power will be eroded by inflation.

Avoiding market risk sometimes looks like a good strategy, right up to the point where the investors find themselves squeezed by rising prices and insufficient savings, at which point they want to reach out for bigger returns. That's precisely what Don was doing, having examined the historical return numbers, which peg equity gains at an average of over 10 percent a year, compared with a return slightly below 6 percent for Treasury bonds.

The problem is that historic returns are not annual or future, which makes volatility the real enemy of Don and Anne.

Whatever mutual fund they pick won't go to zero because, loosely speaking, every stock a fund holds would have to become worthless for a fund to wipe out all shareholders. That's not happening in a well-diversified fund.

But significant declines are in the realm of possibilities, and an ultra-conservative investor who bails out at the first sign of trouble has, in fact, bought that trouble, rather than merely renting it on the way to getting those historic average returns.

"I've worked with a lot of clients who want to go into stocks at a later age because they're afraid of running out of money," says Diahann Lassus, a financial adviser with Lassus Wherley & Associates in Providence, N.J. "Spreading their risk around makes sense, and they may know that they'll do better in the long term, but it's still an eye-opener when you are in the market for the first time and the market goes down, no matter what age you are when that happens."

Lassus and other experts suggest that the best way to confront the problem is to learn more and then ease into the market. The education component is easy to find. The Mutual Fund Education Alliance (www.mfea.com) offers tremendous help for the starting-small, do-it-yourself beginner, while several fund companies (notably Vanguard, Fidelity and T. Rowe Price) and independent research firms (Morningstar) provide exceptional free resources on their Web sites.

Easing into the market, in this case, most likely involves an index fund, replicating the market and aiming for the historical returns that enticed Don and Ann in the first place.

While a young investor venturing into the market for the first time might dive in head-first, experts suggest that seniors taking their first steps into the market should put 15 percent - but no more than 50 percent - of their assets in the market.

Dollar-cost averaging - adding money to an index fund account each month - was suggested. The more comfortable the investor becomes, the more they can diversify their risk, expanding from a broad market base to cover small stocks, international companies and more.

Says Lassus: "It's never too late for someone to make their first move in the market, but they should watch out for `first cruise syndrome,' where a person who gets seasick on their first cruise never wants to go again. They need to understand that they a few rough waves do not mean they have to abandon ship, at which point they can stay on board and, in the end, enjoy the trip."